Big Ifs

‘I know this motor will push the aircraft and I’m confident it will fit in the space we have available for it,’ says Walt Klein, Delta’s director of engineering, quality and training . . . . Klein estimates the system will earn its certification and be ready to retrofit on Delta’s 737s by 2009. ‘It won’t be the most difficult installation we’ve ever done,’ says Klein. But it may be one of the most cost-effective. ‘Financially it’s a no-brainer,’ he says.

Und Was Haben Vir Hier? The spelling is a little funny, but I think it’s the Advanced Explorations CEO telling an interviewer he is bullish on Roche Bay.

At $7 a share, BOREF’s market cap is $35 million. (People routinely pay more than that for paintings.) If either the Wheel Tug or the Roche Bay project pans out, let alone both – big ifs to be sure – it would be worth well north of ten times what it’s selling for now.

DON’T SELL YOUR FMD

Of Thursday’s after-the-close quarterly results my guru writes: ‘We got better than expected on both earnings and revenues – even after a negative adjustment in the discount rate, which knocked earnings down by roughly twenty cents a share. (Additional conservatism was added in some of the lesser accounting treatments as well.) All this in a very difficult securitization environment, so, going forward, margins should improve. Also, they reported an impressive inventory of loans available for securitization in December. With $1.80 in earnings already booked for the first fiscal quarter, I’m looking at roughly $5.25 for the full fiscal year (assuming some mild improvement in the asset-backed-securities markets over the course of the year, which seems reasonable since we’re already seeing a little early stabilization). That puts us at a 7x multiple for a 35%+ grower. Really pretty unbelievable. And watch for further dividend increases.’

☞ If, two years from now, earnings have grown by 25% in each year and the multiple has jumped to a still very staid 12 times earnings – big ifs to be sure – my math puts the stock price at $98, up from Friday’s $39. (And even $39 is up from the $25.50 or so we started at a year and a half ago, with a dollar-fifty or so in dividends along the way.) If it grew at 30% a year for two years and commanded a 15x multiple . . . well, what is life without a dream?

DON’T SELL YOUR HAPN WARRANTS

In a sense, they are a better value here, at 50 cents, than they were a few weeks ago at 25 cents. Because a few weeks ago, there was the real chance the InfuSystems acquisition might be nixed, rendering the warrants almost immediately worthless.

Now, it would take more than three years – specifically, until April 11, 2011 – for the warrants to be rendered worthless (which they would be if the underlying stock were $5 or below).

And if the underlying stock hit $8.50 at some point between now and then – abig if to be sure – our 50-cent warrants would be worth $3.50 (because they’d give us the right to buy $8.50 of stock for $5).

Even if the stock were ‘just’ $6 (and of course there’s no guarantee of that, either), we’d have a double.

There is no question this is risky. But if anything, in my little screeds in this space, I may have been underestimating the warrants’ value a little, for two reasons.

First, in my little ‘black box’ calculations, I’ve been using ‘1100’ as the number of days to expiration. Actually, it’s more like 1260 (and 1259 tomorrow and 1258 the day after that). This makes a small difference. Using Friday’s closing price of $5.05 for the stock, and a ‘risk-free interest rate’ of 4.25%, and a volatility of 40%, at 1100 days the black box spits out $1.63. But using 1260 days: $1.75. Hey, every dime helps.

Let me quickly remind you that neither of those numbers takes into account the ‘cap’ on our potential profits.

(With most options, your gain is, at least theoretically, unlimited. With these warrants, the gain is capped just a little above $3.50, because the company can ‘force conversion’ of the warrants if the stock hits, and for 20 consecutive trading days stays above, $8.50.)

But that’s the second place I may have been too conservative. Because in trying to adjust my numbers for it, I’ve been using the suggestion a couple of you offered . . . namely, to use the same black box to calculate the value of a warrant with a strike price of $8.50 and subtract it, since that’s in effect what we’re giving up with the warrants we own – all the gain above $8.50 or $8.75.

(I say ‘or $8.75’ not because the terms of the warrant are unclear, but because if the stock does hit and stay above $8.50 for 20 days, it may go a little higher at some point during those 20 days. That’s what happened with GLDD. So our true upside might be more like $3.75. )

Well, one of you with much fancier tools at his fingertips, writes:

After reading your warrant valuation analysis this week, I decided to double check your numbers using a fairly sophisticated option valuation modeling system that I use at the investment bank where I work. It can take into account the $8.50 ‘callable’ feature. And it suggests you’ve overestimated the damage that callable feature does.

Guessing the correct volatility number is just that, a guess (I think 25% is a better guess than the 40% you’ve been using, given the huge overhang of warrants), so I’ve created a grid showing the value of the warrants at various prices of the underlying stock and various volatility levels:

Stock

Vol = 25%

Vol = 35%

Vol = 45%

$4.50

$0.83/$0.87

$1.07/$1.19

$1.26/$1.50

$5.00

$1.13/$1.20

$1.35/$1.53

$1.53/$1.85

$5.50

$1.45/$1.57

$1.65/$1.90

$1.80/$2.22

$6.50

$2.13/$2.38

$2.26/$2.68

$2.36/$3.00

The first price in each cell shows what my model thinks the warrants are worth; the second, higher, number, just by way of comparison, shows what the value would be if the warrants didn’t have that annoying $8.50 forced conversion feature.

☞ The bottom line of his endeavor is that ‘our’ back-of-the-envelope method may have been penalizing the warrant a little too much. And that, with the stock currently at $5, under almost any assumption, the warrants are a steal at 50 cents.

Then again, I could offer you two-to-one odds on the flip of an honest coin – HEADS YOU WIN $10,000, TAILS YOU LOSE $5,000 – and it would be a great bet for you to take (if you could afford the risk). But that doesn’t mean you would win.

So the only real bottom line, at the end of the day, will be how well or poorly InfuSystems performs, and what people are willing to pay for the stock. I’m hoping for $8.50 one day and seven times today’s price on the warrants. At the same time, I am only making this bet with money I can truly afford to lose.

DON’T SELL YOUR AII WARRANTS

Well, these, too, seem cheap. The stock closed at $9.39, so the warrants, giving you the right to buy it at $7.50 once the Boise acquisition closes, have an intrinsic value of $1.89. (Right? Subtract $7.50 from $9.39 and you get $1.89.) Yet they closed at $1.90, giving a value of just one penny to their ‘time value’ – namely, the right to exercise them any time between now and mid-2011. The reader above says his black box put their current value at more like $3. So tempting as it may be to take a quick 30% or 50% or 70% profit (depending on what you paid for yours this summer), that’s not the point of a bet like this. Fully recognizing that we may lose it all, the point of a bet like this is to make several times our money, lightly taxed as a long-term capital gain.